Downsizing the American Dream

On Friday, the Obama administration outlined plans to unwind the government-sponsored mortgage agencies Fannie Mae and Freddie Mac, essentially asking Congress to hand over responsibility for the nation's home mortgages to the very industry whose reckless support of the corrupt lending practices that provoked the current crisis.

Sounds like a terrible idea, yes? But the administration has some big plans for taming the feral financial services industry, and the Dodd-Frank financial reform bill was just the beginning. Central to the administration's proposal is making sure credit is available to all communities; in effect, the administration is reinventing the Community Reinvestment Act (CRA) -- a 1977 law designed to prevent commercial banks from discriminating against low-income communities, especially communities of color, through practices like redlining -- for a world in which mortgages are much more likely to be backed by investor capital than consumer bank deposits. If the administration succeeds -- and that's a big if -- homeownership stays alive as a widely achievable dream. If it doesn't? We could be on a road back to an era when redlining by bankers denied credit to many deserving borrowers and communities.

Fannie Mae and Freddie Mac have been on federal life support since the housing crash and are currently keeping the home-lending market going. The 32-page Obama administration proposal comes wrapped in an impressively candid premise: "We must decide," the white paper concludes, "what we take to be the right balance between providing broad access to mortgages for American families, managing the risk to taxpayers, and maintaining a stable and healthy mortgage market."

That is indeed the choice before the nation right now. For three-quarters of a century, the federal government has provided generous support to home-mortgage borrowers, much of it through its sponsorship of Fannie Mae. Fannie Mae and its 1970s spawn, Freddie Mac, grew to become the heart of the secondary mortgage market -- the place banks go to sell mortgages for capital, which in turn could be used to provide further loans.

For the three decades that Fannie Mae remained a government agency, this worked well enough (though not well enough for the African American and urban borrowers who were systematically excluded from the system's benefits). But once the Johnson administration sold Fannie Mae to private shareholders in 1968, the game changed; shareholders benefited richly from the government subsidy and implied guarantee. At the peak of the mortgage bubble, the companies' quest to sustain market share and share prices pushed them to join the subprime lending stampede. Fannie and Freddie didn't cause the financial crisis, but the staggering growth of these institutions -- on Wall Street, Fannie shares outperformed even the internet-bubble 1990s stock market -- made their collapse especially harmful.

Politically and practically, Fannie and Freddie's shut-down has become inevitable. But the administration is looking to do much more than shift the foundation of a distended mortgage finance business from the public to the private sector. The White House now asserts that housing has devoured far too big a share of resources at the expense of other sectors of the economy. This position is a bold one, reversing a sacrosanct credo of American politics: bolstering homeownership brings big returns to the economy and to whichever party held the White House.

The administration has now forced a tough political question out into the open: What price is the nation really willing to pay for widespread homeownership? Fannie and Freddie may be easy targets for populist bashing, but they are also the reason that middle-class Americans can get a 30-year, fixed rate mortgage that they can refinance at any time without penalty. It's why home sellers can still find buyers who have financing to close the deal. Now the administration is saying not only are those institutions going to exit the stage, but that the government guarantee itself is on the chopping block.

The Treasury white paper offers three different proposals, each with a different balance of risk and benefit to the public. Under the most transformative scenario, the government's role would be limited to supporting the Federal Housing Administration (FHA), which provides mortgage guarantees and insurance for moderate-income buyers to buy inexpensive homes; everyone else would have to borrow in an exclusively private market that would not only be a costlier place to do business but make consumers take on a share of risk with prepayment penalties and adjustable-rate interest payments.

The second proposal would make a government guarantee available for a broader array of mortgages, but only when private-sector backing isn't available. And the final scenario, similar to a proposal shopped by the Center for American Progress, would allow financial institutions that met strict underwriting standards to get a safety net from the Treasury, which would lower consumers' cost of borrowing from those institutions.

The Treasury's frank presentation appears designed to force tough political decisions in Congress. Get the government out of the mortgage business, it effectively says, and you'll have to explain to voters why they're paying 8 percent interest or can't find a buyer for their home. Or you can keep government in to keep mortgages widely available and rates low, which entails the types of risk that made the collapse of Fannie and Freddie so costly.

Sooner or later, Congress will have to choose one of these options. But just as important to the future of homeownership is how far the House and Senate will now move to regulate the sale of mortgage-backed securities on Wall Street beyond the relatively modest measures in Dodd-Frank. Whether homeownership remains a broadly realized institution or becomes a privilege for a relative few depends largely on how far the Obama administration can push Congress to demand broad and fair access to credit for all corners of the country.

"We will work with Congress to ensure that all communities and families -- including those in rural and economically distressed areas, as well as those that are low- and moderate-income -- have the access to capital needed for sustainable homeownership and a range of rental options," the Treasury pledges. That's not just a great idea; it's an essential one. In fact, this is a restatement of the Community Reinvestment Act. When CRA became law in 1977, it required federal banking regulators to make sure that any federally regulated bank was "meeting the credit needs of its entire community, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of such institution." Now, the administration wants to apply that principle for the first time to the Wall Street issuers of mortgage-backed securities.

This promise is a close equivalent of the individual mandate in health care reform: utterly necessary as a practical and ethical matter, and also politically radioactive. If private bankers can exclude borrowers based on crude assumptions about the risk of lending in their neighborhoods -- or just as problematically, target them for high-cost products -- they will. Excluded borrowers and communities get dumped into the government's FHA insurance pool or, worse, must go without access to mortgage credit at all. Years of painful experience have shown that such a segregated, uncompetitive mortgage market is a destructive force in communities lenders have shunned, where the banks' credit judgments quickly warp into self-fulfilling prophecies of neighborhood disinvestment.

Yet any effort in Congress to fairly serve borrowers and markets is destined to slam against a wall of opposition from Wall Street lobbying groups like the Securities Industry and Financial Markets Association, and from Republicans who have already gleefully blamed CRA for the financial crisis. In its only concrete recommendation for "ensuring that capital is available to creditworthy borrowers in all communities," the Treasury white paper calls on Congress to ask Wall Street firms to reveal detailed information about the credit, demographics and geography underlying loans bundled into the securities they sell - increased disclosure that bankers have strenuously resisted in the past.

Assume, we sadly must, that the "access to capital all communities" bit is a wish, that like all wishes could be fulfilled but quite possibly won't be. Then look again at the administration's proposal. Housing finance reform without CRA 2.0 is like health insurance reform without the individual mandate and requirement that insurers cover pre-existing conditions: it's a recipe for a future of dramatic and widening inequalities, with serious consequences for the households and communities on the wrong side of the divide.